Big Mac index

Big Mac index Definition

The Big Mac index is an informal way of measuring whether one currency is at the theoretically correct exchange rate with another currency. The measure assumes that the theory of purchasing power parity (PPP) holds.

The Big Mac PPP exchange rate between two countries is obtained by dividing the cost of a Big Mac in one country (in its currency) by the cost of a Big Mac in another country (in its currency). This value is then compared with the actual exchange rate; if it is lower, then the first currency is under-valued (according to PPP theory) compared with the second, and conversely, if it is higher, then the first currency is over-valued.

For example, suppose a Big Mac costs £2.00 in the United Kingdom and $2.50 in the United States; thus, the PPP rate is 2.00/2.50 = 0.8. If, in fact, the dollar buys £0.55, then the pound is over-valued with the respect to the dollar.